tv Bloomberg Real Yield Bloomberg October 15, 2017 5:30am-6:01am EDT
as the largest u.s. banks report earnings, they are revealing a less credit worthy american consumer. how big a concern is that? we start with the big issue. markets continue to shrug off risk. >> it is it really surprising when you look at all the events that have gone on the. the markets do not react to it like they used to. >> i am nervous. areeems like when investors nervous, they are prone to being spooked. are keeping the paddle too much on the gas. we are sucking out of the volatility in a way i do not think is conducive to growth. do not see ane, i overwhelming bubble, i just think there is a risk of the markets are not taking into account. lisa: a lot of angst, not a lot
of action. is -- and it's got kimball, portfolio manager at bmo tch. i want to start with the ecb. i am struck by the fact that the bond market rallied. people bottom bonds. bought ons. >> the consensus last night was the ecb would finish tapering around the second half of next year. what is being talked about now is a little bit beyond that. we are not surprised by that. we came into the year feeling constructive on the eu.
we went longer on the euro. eu recovere seen the well. growth has been good, inflation is ok. at this point, we think of growth is going to decelerate. todo not think it is going reach of the eu's forecast. result of that, we think the ecb is going to have to buying andhe market doing qe for longer than the market expects. lisa: if you see europe decelerating, if you see the central bank continuing its bond purchase, michael, given that backdrop, nothing can cause the u.s. treasuries to sell off, right? withat is the problem that. every time a rate start to go up here, we look really cheap to foreign countries. -- has buying has much come much further out the curb than it used to. a lot of investors are used to buy two-year and five-year
treasuries are out there buying 10 year and a longer treasuries. to get a really big move in the market, what we need is inflation. for two reasons. one is the obvious. my cash flow is worth less if inflation is up. we have seen all these pot -- all these people piling and their risk assets in order to reach a bit -- reaching their target. take a little more risk to hit my yield bonus. when rates are to rise, people start to pull out of those assets. every time it looks like rates are going to take off, we see jitters in the equity market. we see jitters in the corporate bond market, and the fed a says it let me back off, they get dovish, and we rallied back.
we rallied back. that will continue to happen as long as inflation is low. towe see inflation start pick up, the fed cannot have that put up. lisa: do you think it is plausible we will see that inflation? >> not soon. i think we will see a little higher than today, but not dramatic. >> the way we position the core plus bond a fund is to take advantage of what my colleague was talking about. as interest rates rise, we are starting to see trepidation of people who owned those assets to rotate back into more traditional asset allocation tools. part of that is owning longer dated securities. we found a lot of value in -- 10, and0 and corporate debt. a bite been churning out in bringing our pro-folio durations back towards neutral
with the expectation the upside case for rates is continuing to dwindle. lisa: i am struck by the fact we are not seeing that much inflation. we are not seeing that much growth. people are piling into risky stuff. the imf talked a lot about financial security. then you have the yield curve, which continues to flatten, suggesting growth is only going to slow down further. make youoint does this concerned about the financial stability we are looking at if there is a downturn. isi think the yield curve not suggesting we are going to have a greater chance of's -- of recession. i think the reason we are planning is we still see a lot of demand for yield. absolute, iteld is is low, so people have to go out the curve. i think you are seeing the curve
of flattening because we are seeing a little more inflation. that is why you are seeing the yield curve the flatten. lisa: you think people are misinterpreting at? >> it is not inverted. lisa: do you think the -- of the curb -- the curve could invert and then your time. these -- of the curve is going to steepen a little bit going forward. to get perfectly flat, we would need to have an imminent recession. if you look at consumer balance sheets, they are extraordinarily strong. consumer spending should hold up even if we have stocks -- have a shocks to it. it is the biggest piece of gdp do have decent growth going forward. no recession soon. >> we would agree.
we look at the underpinnings of what is going on with the yield curve. it is emblematic of this disagreement of the investor community has had with the fed. i think the market is interpreting that, particularly some of the comments that came out from fed governors earlier in the week about that word, there is a bit of wrangling going on with how much longer we are willing to wait until the word transitory is removed. that flattening of the curve reflects the market telling the fed there are some structural underpinnings you need to start acknowledging. time, gbp has been strong, and we think there is an upside case for it -- for inflation to accelerate. who matters more, the ecb or the fed? >> when we talk about quantitative easing, the ecb
matters more. the fed has already been clear by what a plan to do with that. lisa: how many hikes do you think we going to see from the fed next year? >> i think we are going to get a quarterly base going forward. growth backward -- even though inflation is below where they would like it to be, that is the norm. above 2% aboutly a quarter of a time -- a corner of the time. you still need to take some insurance out. if you wait until you see inflation, it is too late. particularly because everybody is piled into more risk. this is the problem, markets seem less liquid than they used to be a cousin of the lack of volatility. if the fed does something and goes hard, they're more likely
2.53,to cover ratio of the highest level since september 2015. on the corporate side, walmart sold bonds. they issued $6 billion of unsecured bonds in six parts, with the longest portion a 30 year security, yielding 75 basis points. junk or rated companies have raised over $14 billion this month. the second half of october usually sees a second month of issuance, making it very likely it will had a five-year peak for sales. still with us, michael cloherty, bonnie wongtrakool and scott kimball. i'm struck by what you all are saying to me and what we hear again and again. we just don't see the risk. people will continue to buy bonds. we saw yet another inflow that was the biggest weekly inflow over the past week since 2015. it makes me wonder why not lever up?
why not just get as much leverage as you possibly can and pour your money into absolutely anything risky you can find? michael? michael: sadly i think we have seen a few people doing that. unfortunately, it is the people under the most stress. retirees that need some income, other people like that who are least able to sustain the loss. pension funds, other folks like that, small banks. lisa: are you seeing pension funds lever up? michael: taking more risk than they would have before. lisa: what markets? michael: it is really . you're forced to chase yield because you have to meet some target. you have to pay retirees. you have to meet some earnings targets. you can't do that buying treasuries, so you are forced to slide out the scale. lisa: scott, have you been more willing to use leverage given the backdrop we are looking at? scott: our core plus bond fund does not use leverage as a tool.
we move around between 80% mix of investment-grade securities with the opportunity to do with the 20% below investment-grade. the opposite of the trade you -- we have been the opposite of the trade have outlined, which is we are more willing to move further out the yield curve and investment-grade to capture yield as opposed to trying to stay low on duration and buy high-yield at a low high-yield premium. so effectively, our viewpoint there is we think there are better opportunities ahead look at some of these risk assets. right now we are more on the investment-grade side of things. bonnie: i'd say similarly, we also don't use leverage in our core plus bond funds. but in terms of valuations, we think the fundamentals are very good but we also think the valuations are relatively full for credit. so what we have done is cycled out of some of that and been very selective about where we have those holdings and then move them into other markets we think have more value, like emerging markets. lisa: i want to pick up on emerging markets in a minute. i just want to ask both scott and bonnie, do you see investors engaging in behaviors that
concern you as far as how much leverage they are taking on? in other words, borrowing short-term in order to invest longer-term, as well as more of the risk spectrum than they would like to? scott: i think this is sort of the corporate bond or credit bull market that is the most hated in history. people have been trying to predict its demise since the day it started. so very candidly, when we look back at our own expectations for credit risk and credit return, they continue to surprise to the upside. at this point, we don't think the risk premium is high enough to own super subordinated structures and take on too much risk. particularly, further your risk out the curve. but at the same time, there are a lot of investors engaged in that. that is one of the concerns we have about when this credit cycle ends, when the cushion pops. it may be more pronounced. bonnie: we have seen investors in this search for yield as spreads have compressed in certain sectors moving their
allocations to other sectors. but i would not characterize it as over-levering. lisa: i am struck by the lack of assets. people talk about the amount of cash. i think the flip side of that is there are not enough bonds for people to buy. you see synthetics come back, synthetic cbo's coming back in -- and people creating contracts to go around risky bank bonds in europe. i'm just wondering, is this natural? is this still small potato stuff? or is this becoming a more prevalent issue as people search for something to buy? >> again, is it a systemic risk, no? we are not anywhere close to that amount of outstandings yet. we have seen looser language on some corporate bonds. less security. people stress for yield and they have to give up something. so you are seeing a little bit of a slide there. overall, the economic backdrop still looks bright enough you will not expect a massive wave
of defaults coming in that would be seen in a recession that would really hurt corporates. what worries me most about corporates is this huge move towards passive investing. if we get a surprise default from somebody, our panelists know how to handle that. in a how to value that security. -- they know how to value that security. some of the passive folks, i see that only index, i sell it, i move on. as the passive thing gets bigger and bigger and bigger the risk of a surprising fall -- it was before your days, but if we get that, it will be much messier. lisa: and bonnie, quickly, you you said you're going into more investment-grade then high-yield debt. investment-grade is also highly valued. bonnie: we are going into more emerging markets. lisa: emerging markets and high-yield, scott is going more into investment grade, right? scott: in the market we are can that continuing to see very strong flows.
i have to echo michael's sentiment about passive versus active. obviously, core plus is an active fund. we do measure credit risk on an individual security basis, but with passive you do not do that. lisa: everyone is going to be sticking with us. we will delve into the emerging markets more. michael cloherty, bonnie wongtrakool, scott kimball. let's get a market check on where bonds have been in this week. 2, 10, 30 all getting tighter. people piling into bonds cannot get enough of them. still ahead, the final spread. the weekend features the 19th -- week ahead features the 19th chinese communist party congress. the country's most important political events that only occurs twice a decade. this is "bloomberg: real yield." ♪
♪ lisa: i'm lisa abramowicz. this is "bloomberg: real yield." time for the final spread. chair janet yellen takes part of a group of 30 international banking seminar. catalonia faces a deadline regarding its independence. greek prime minister alexis tsipras visits the white house. morgan stanley and goldman sachs report earnings, and china holds its 19th communist party congress, the country's most important political event. still with us is michael cloherty, bonnie wongtrakool, and scott kimball. i want to talk more about what you were talking about, bonnie, with respect to shifting away from high-yield credit in the u.s. and moving more to emerging markets. how are you doing that? i noticed that recently, an increasing number of firms are putting more money into local currency, emerging markets debt, and away from dollar-denominated emerging-market debt.
is that what you are doing as well? bonnie: so emerging markets, we did start to move into that earlier at the beginning of the year when we felt that was a good value. since then spreads have compressed, particularly on the dollar denominated debt. at this point, local currency bonds do see relatively more -- seeing relatively more attractive and we do have a decent allocation into that as well. i would say others are following on that, but it has more room to go. if you look at the differential and real yields between developed economies and emerging market economies, we think it still holds value. lisa: scott, are you also shifting more of your portfolio into emerging markets? scott: we have not really shifted our core plus strategies around e.m., greater allocation. but we're emphasizing looking for opportunities in em -- particularly in e.m. corporate. we do earn a yield premium due to the fact that the company is domiciled in emerging-market. lisa: michael, how concerned are you that this is a leveraged dollar bet? basically, as soon as the dollar weakens, emerging markets look better and better.
but as soon as the dollar strengthens, people get a rude awakening? michael: right, so some of the bet is, do you think the fed will tighten really hard and fast or not? if you think you are going to get an aggressive tightening here, that is probably not going to work out too well. i think it is unlikely we will get a really aggressive fed. that said, we have had this gap between what the market has been pricing and what the fed has been saying. chairome of the new coming in. wild't think you'll see differences. will see a change in how the market reacts. >> are there any countries you are avoiding? >> we are very selective. you do not want passive exposure
because different countries have different risk. there will be do political risk across the entire world, let alone them urgently -- emerging markets. but in terms of credit we do like, we do like argentina, brazil, india and indonesia. risks to china, for example. china, we are confident china can kind of continue to decelerate growth, but we are cognizant that a little misstep could really rock the market. you need to become is of that and navigate accordingly. lisa: this is the period where we do rapidfire. do you think is likely we see a recession within the next 18 months? michael: no. bonnie: no. scott: no. lisa: what is riskier in the next six months, u.s. treasuries or emerging-market debt? michael: em. scott: em. bonnie: treasuries. lisa: interesting. lisa: which is more prone for losses, german or u.s. government bonds?
michael: u.s. bonnie: u.s. scott: german. lisa: german, interesting, and what is more overvalued? u.s. investment-grade bonds or u.s. high-yield debt? scott: high-yield. bonnie: high-yield. michael: high-yield. lisa: thank you so much. michael cloherty, bonnie wongtrakool and scott kimball. from new york, that does it for us. we will see you next friday at 12:00 new york time, 5:00 p.m. in london. jonathan ferro will be back in the seat. this is "bloomberg: real yield." ♪
under pressure like never before. and it's connected technology that's moving companies forward fast. e-commerce. real time inventory. virtual changing rooms. that's why retailers rely on comcast business to deliver consistent network speed across multiple locations. every corporate office, warehouse and store near or far covered. leaving every competitor, threat and challenge outmaneuvered. comcast business outmaneuver.